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FINANCIAL CRISIS INQUIRY COMMISSION REPORT
thing that was constant about the crisis is that we were always behind. It was always
morphing and manifesting itself in ways we didn’t expect,” Neel Kashkari, then assis-
tant secretary of the treasury, told the FCIC. “So we knew we’d get one shot at this au-
thority and it was important that we provided ourselves maximum firepower and
maximum flexibility. We specifically designed the authority to allow us basically to
do whatever we needed to do.” Kashkari “spent the next two weeks basically living on
Capitol Hill.” As discussed below, the program was a tough sell.
MORGAN STANLEY: “NOW WE’RE THE NEXT IN LINE”
Investors scrutinized the two remaining large, independent investment banks after
the failure of Lehman and the announced acquisition of Merrill. Especially Morgan
Stanley. On Monday, September , the annual cost of protecting million in
Morgan Stanley debt through credit default swaps jumped to ,—from
, on Friday—about double the cost for Goldman. “As soon as we come in on
Monday, we’re in the eye of the storm with Merrill gone and Lehman gone,” John
Mack, then Morgan Stanley’s CEO, said to the FCIC. He later added, “Now we’re the
next in line.”
Morgan Stanley officials had some reason for confidence. On the previous Friday,
the company’s liquidity pool was more than billion—Goldman’s was
billion —and, like Goldman, it had passed the regulators’ liquidity stress tests
months earlier. But the early market indicators were mixed. David Wong, Morgan
Stanley’s treasurer, heard early from his London office that several European banks
were not accepting Morgan Stanley as a counterparty on derivatives trades. He
called those banks and they agreed to keep their trades with Morgan Stanley, at least
for the time being. But Wong well knew that rumors about derivatives counterpar-
ties fleeing through novations had contributed to the demise of Bear and Lehman.
Repo lenders, primarily money market funds, likewise did not panic immediately.
On Monday, only a few of them requested slightly more collateral.
But the relative stability was fleeting. Morgan Stanley immediately became the
target of a hedge fund run. Before the financial crisis, it had typically been prime bro-
kers like Morgan Stanley who were worried about their exposures to hedge fund
clients. Now the roles were reversed. The Lehman episode had revealed that because
prime brokers were able to reuse clients’ assets to raise cash for their own activities,
clients’ assets could be frozen or lost in bankruptcy proceedings.
To protect themselves, hedge funds pulled billions of dollars in cash and other as-
sets out of Morgan Stanley, Merrill, and Goldman in favor of prime brokers in bank
holding companies, such as JP Morgan; big foreign banks, such as Deutsche Bank
and Credit Suisse; and custodian banks, such as BNY Mellon and Northern Trust,
which they believed were safer and more transparent. Fund managers told the FCIC
that some prime brokers took aggressive measures to prevent hedge fund customers
from demanding their assets. For example, “Most [hedge funds] request cash move-
ment from [prime brokers] primarily through a fax,” the hedge fund manager
Jonathan Wood told the FCIC. “What tends to happen in very stressful times is those
